Extracted from Law360
In the last weeks of the Biden administration, the Consumer Financial Protection Bureau rushed to issue a number of new regulations, including a final rule on overdraft credit products offered by very large financial institutions — banks and credit unions with more than $10 billion in assets.[1]
The overdraft rule changes long-standing treatment of overdraft products, which historically have been excluded from the regulatory framework for consumer loans, by requiring very large financial institutions, or VLFIs, to comply with disclosure and other consumer protection requirements to certain overdraft products based on the fee imposed in connection with an overdraft.
The overdraft rule was immediately challenged on Dec. 12 in Mississippi Bankers Association v. Consumer Financial Protection Bureau and Rohit Chopra in the U.S. District Court for the Southern District of Mississippi on the basis that the CFPB exceeded its statutory authority. The rule has also been challenged in Congress. Its future is uncertain.
Summary of the Rule
The overdraft rule amends federal law to bring discretionary overdraft services offered by VLFIs under the Truth in Lending Act, or TILA, and its implementing regulation, Regulation Z. It also says that when overdraft credit is accessed by a hybrid debit-credit card, the same regulations that apply to credit cards should be applied to such overdraft credit.
The overdraft rule introduces a definition for "overdraft credit" and distinguishes between "covered overdraft credit" and "non-covered overdraft credit." Overdraft credit is generally defined as credit extended when a consumer has insufficient or unavailable funds in their account to pay a transaction.
Overdraft credit becomes covered overdraft credit if it is subject to a finance charge or payable by written agreement in more than four installments.
To capture only the type of overdraft credit the CFPB wishes to regulate under Regulation Z as covered overdraft credit, the overdraft rule creates a new defined term — "above breakeven overdraft credit" — and excludes such overdraft credit from the exemption to the definition of "finance charge" under Regulation Z for "charges imposed by a financial institution for paying items that overdraw an account."
"Above breakeven overdraft credit" is generally defined as overdraft credit on which a VLFI "imposes a charge or combination of charges exceeding the average of its costs and charge-off losses for providing non-covered overdraft credit."
The charges will be deemed to exceed the average costs and charge-off losses if they exceed the greater of $5 or the pro rata share of the VLFI's total direct costs and charge-off losses for providing noncovered overdraft credit in the previous year.
A charge that exceeds this amount will be considered a finance charge, and therefore, imposing such charge on overdraft credit will result in the overdraft credit being considered covered overdraft credit.
As a result, VLFIs will have to choose one of the following options in connection with fees for overdraft credit: (1) capping fees for overdraft credit at the greater of $5 or at an amount that covers their costs and losses; or (2) disclosing the terms of overdraft credit in accordance with TILA and Regulation Z.
The overdraft rule also largely adopts the other changes considered in the proposed rule, such as:
- Prohibiting compulsory use of preauthorized transfers from consumers' accounts to repay covered overdraft credit.
- Requiring covered overdraft credit to be structured as a separate credit account rather than as a negative balance on a checking or other transaction account.
- Applying the Regulation Z credit card provisions to covered overdraft credit accounts if the account can be accessed by a hybrid debit-credit card, which is "any card, plate, or other single credit device that a consumer may use from time to time to obtain covered overdraft credit from a very large financial institution."
- Adopting the proposed change that breakeven overdraft credit will no longer qualify as "incidental credit" under Regulation B and will be subject to certain requirements under the Equal Credit Opportunity Act and Regulation B, including notice and recordkeeping requirements, and examination of overdraft practices.
- Clarifying that covered overdraft credit will not be subject to the Regulation E opt-in requirement that applies to noncovered overdraft credit for one-time debit card and ATM transactions.
The overdraft rule is scheduled to take effect on Oct. 1.
The CFPB's Statutory Authority (or Lack Thereof)
A group of financial trade associations and banks immediately challenged the overdraft rule in the Southern District of Mississippi.
They argue that the CFPB exceeded its statutory authority under TILA in issuing the overdraft rule. And their cry has been taken up by numerous amici, including the U.S. Chamber of Commerce and credit union and bankers associations nationwide.
At the heart of the case are debates over the definition of the word "credit," whether TILA is merely a disclosure statute and the emerging impact of the major questions doctrine.
TILA regulates credit products and defines "credit" as "the right granted by a creditor to a debtor to defer payment of debt or to incur debt and defer its payment."[2]
Historically, discretionary overdraft services were not treated as extensions of credit because financial institutions decide whether to pay or decline an overdraft at will and do not grant consumers the right to overdraw their accounts. Fees charged in connection with overdraft services are also excluded from Regulation Z's definition of finance charge.[3]
In the overdraft rule, the CFPB changes this historical framework and explains when overdraft services fall within TILA's definition of "credit" and when overdraft fees satisfy the definition of a "finance charge."
In response, the plaintiffs and their supporters have compiled decades of federal agency statements supporting their position that overdraft services have not, and should not, be treated as credit.
One example — the Official Staff Commentary to Regulation Z published in 1981 — highlights the difference between an extension of credit and discretionary overdraft services.[4]
According to the commentary, a credit card — i.e., a card that can be used to obtain credit — includes a "card that guarantees checks or similar instruments, if the asset account is also tied to an overdraft … line of credit," but does not include "a check-guarantee or debit card with no credit feature or agreement, even if the creditor occasionally honors an inadvertent overdraft."
And another example — an amicus brief the Federal Reserve Board filed in the U.S. Court of Appeals for the Ninth Circuit more than 20 years later in In re: Washington Mutual Overdraft Protection Litigation — holds fast to the conclusion that "non-written-agreement, overdraft programs" — i.e., discretionary overdraft services — "were not subject to Regulation Z."[5]
These documents, and the myriad others in the plaintiffs' and their amici's briefing, present a historical narrative that may be difficult for the CFPB to overcome when defending the lawsuit.
Additionally, the plaintiffs assert that TILA is primarily a disclosure statute and that the CFPB exceeded its authority under TILA by imposing substantive restrictions on overdraft services. While TILA primarily may be a disclosure statute, it also provides some substantive protections.
However, these protections were added by amendment in 2009 and are generally limited to the types of credit products specifically identified in the statute. For instance, TILA limits certain fees and restricts interest-rate increases for credit card accounts under an open-end consumer credit plan.[6]
Finally, both of these arguments — and ultimately the outcome of the case — may turn on the court's application of the major questions doctrine.
According to the U.S. Court of Appeals for the Fifth Circuit in last year's Mayfield v. U.S. Department of Labor, a court may strike an agency action under the doctrine "when the agency claims the power to resolve a matter of great political significance" or "when the agency seeks to regulate a significant portion of the American economy or require billions of dollars in spending by private persons or entities."[7]
Each of the plaintiffs' arguments feed into these considerations. The impetus for labeling overdraft services as extensions of credit seems politically motivated and could have a significant economic effect.
As the plaintiffs flag in their briefing, the overdraft rule looks to be part of a larger political press by former CFPB Director Rohit Chopra's targeting of "junk fees."[8]
Also, the overdraft rule could have billions of dollars in impact. According to the plaintiffs, consumers paid out more than $6 billion in overdraft fees to VLFIs just in 2022.[9] Either might be enough to invoke the major questions doctrine.
Impacts of Recent Developments at the CFPB and in Congress
Recent changes at the CFPB may affect the overdraft rule's status. On Feb. 1, Chopra was removed from his role as the CFPB's director.
Following his removal, the parties to the overdraft rule litigation filed an agreed motion to stay proceedings for 90 days to give new CFPB leadership time to review and potentially reconsider the agency's position on the overdraft rule.
On Feb. 7, Russell Vought was appointed acting director of the CFPB. Shortly after taking over, Vought ordered a halt on all work at the CFPB, including suspending the effective dates of all final rules that have not yet become effective.
It remains to be seen whether the new CFPB leadership will support the overdraft rule. On Feb. 13, resolutions were introduced in Congress to nullify the overdraft rule under the Congressional Review Act.
If the resolutions are approved by the House and Senate and signed by the president, the overdraft rule will have no effect. Only a majority vote is needed to approve the resolutions.
Conclusion
If the litigation proceeds, the legal challenge to the overdraft rule has a real chance of success on the merits. Following the U.S. Supreme Court's direction last year in Loper Bright v. Raimondo that lower courts should "exercise their independent judgment in deciding whether an agency has acted within its statutory authority,"[10] the CFPB may not get a pass on its new rule.
Also, the emerging precedence of courts applying the major questions doctrine to strike down agency regulations should not be overlooked.
New CFPB leadership also may not support the rule and could decide that it would be more efficient to allow the rule to be challenged and struck down than to attempt to repeal the rule, which would require a formal notice-and-comment rulemaking.
Finally, Congressional Review Act resolutions have been successful in the past, so congressional action could also lead to the rule's demise.
[1] 89 Fed. Reg. 106,768.
[2] 15 U.S.C. § 1602(f).
[3] 12 C.F.R. § 1026.4(c)(3).
[4] Fed. Reserve Sys., Truth in Lending, Official Staff Commentary, 46 Fed. Reg. 50,288 (Oct. 9, 1981).
[5] Amicus Br. of Bd. of Governors of the Fed. Reserve Sys., In re Washington Mut. Overdraft Protection Litig., No. 04-55885 (9th Cir. June 2, 2006) (ECF No. 1-1, at 10–11).
[6] 15 U.S.C. §§ 1637(l), (n), 1665d, 16616i-2.
[7] Mayfield v. United States DOL , 117 F.4th 611, 616 (5th Cir. 2024) (quotations and quotation marks omitted).
[8] See Mississippi Bankers Association, et al. v. Consumer Financial Protection Bureau and Rohit Chopra, No. 3:24-cv-00792 (S.D. Miss. Dec. 18, 2024) (ECF No. 13 at 27).
[9] Id.
[10] Loper Bright v. Raimondo , 603 U.S. 369, 412 (2024).